3 Simple Signs Your Stock Is Spending Wisely

Companies spend money to make money. Beyond that simple truth, it's frighteningly easy for investors to bury themselves in books to decide why Bob's Billboards will outperform Sally's Signs. Here are three simple steps to gauge your company's spending habits.

1. Margins
Every company spends money to make money, but some spend way more than others. For utilities, the main expense is the generation and/or distribution of electricity to millions of homes and businesses. Investor lingo describes the difference between sales and costs as "margins," and there are two types that offer the easiest examination.

Operating margins answer the quick and dirty question: "How much did it directly cost to produce our product?" It leaves out all the fluff of executive salaries, write-offs, etc., and is the first stab at measuring a company's spending efficiency.

Profit margin is the exact opposite, and is the number used to find out how much a company finally pockets off every dollar of sales. Profit margin can be more revealing than operating margin, but it's also easier to cook the books through clever write-offs, sneaky mergers, and other accounting tricks.

Here's how some utilities' margins stack up:

Source: Yahoo! Finance and Author's Calculations

Right off the bat, you can see how much margins can differ. The "margin spread" can serve as a useful tool to measure the gap between the two margins. If it's large, companies may have a lot to gain from increased efficiencies. If it's small, the utility might be squeezing all it can out of its sales.

2. Capital expenditures
"Capex" is the best budget line item to determine if a company is reinvesting in itself. Capex includes any spending that goes toward maintenance or improvement of company operations. The metric accounts for internal spending (e.g. equipment upgrades) as well as external spending (e.g. acquisitions). NextEra just bought a 165 MW wind farm this week, Duke Energy is deciding whether to repair or retire a damaged Florida nuclear facility, and Exelon is currently constructing one of the largest solar farms in the world.

Here's how our companies' capital expenditures add up:

Source: Yahoo! Finance

There's a huge spread here, evidence of the inherent differences between many of these companies. Generally speaking, however, a corporation with a sub-par capex should be closely examined. Is the company putting off repairs to make its books look better? Is it focusing on short-term profit rather than long-term value from upgrades? These are questions you'll need to answer.

3. Dividends
Quite possibly the most important way a company "spends" an investor's money is by distributing it back to shareholders via dividends. High yields are enough to make any investor salivate, but dividends should only be used if the company has nothing better to do with its money. If a corporation needs to pay off costly debt, reinvest in its business, or make strategic acquisitions, dividends are not the best choice. But for high-performing stalwarts with more money than they know what to do with, dividends take the pressure off of useless spending.

Exelon recently warned that it may lower its dividend to "remain investment grade." Although dividend investors might moan, its current 7.2% yield is above average and potentially damaging to the company's long-term financial strength.

Here's how each company's dividend looks:

Source: Yahoo! Finance

Warning signs should be going off on Atlantic Power's sub-par profit margins, high capex, and unsustainable dividend yield. Sure enough, our three-step check could've proved helpful to investors a month ago, when the company missed revenue and EPS estimates in the third quarter. For a company like Exelon, calculating a dividend-to-sales ratio can put its yield in perspective by showing the true cost of its distribution. Finally, Dynegy has chosen to forgo a dividend entirely, choosing instead to reinvest in itself as it recovers from bankruptcy.  

Foolish bottom line
Figuring out how a company makes money is important, but these three steps will help any investor answer an equally vital question: How is my investment investing? When you've come up with a reasonable response, you'll be well on your way to making a profitable and informed investment decision.